The best time to invest in shipping?

As I discussed in a Splash article last month, shipping stocks had been caught in a brutal crossfire between the small cap and oil price sell-off during late-2018. The Russell 2000 (RUT) fell by 25% and WTI oil prices had collapsed by 40% during Q4 last year, dragging down shipping stocks which were otherwise enjoying the best rates they had seen in several years.

We noted corporate governance was actually on the uptrend as several firms turned to repurchases to attempt to bridge the unprecedented market mispricing. Keep in mind that these lows occurred within weeks of the LNG sector logging all-time record highs while crude tanker and product tanker rates also hit multi-year highs.

It might seem controversial, but I believe improvements will continue and potential upside is just beginning to emerge. I’ve been quite vocal lately, also discussing these developments at Seeking Alpha and with private investors via our exclusive Value Investor’s Edge platform. Why am I bullish?

1. Record low valuations: Even after the pick-up the past few weeks, shipping companies still sit at lower P/NAV (i.e. tangible book) multiples than we’ve seen even during previous crisis periods such as ’08-’09.

2. Regulatory tailwinds: The ballast water (“BWM”) requirements and related capital expenses are pushing hundreds of previously borderline ships into the demolition yards. IMO 2020 will further separate modern efficient vessels from older fringe assets.

3. Low orderbooks: Forward supply expectations (in terms of % growth) are near record lows for many of the key tanker and dry bulk sectors.

4. Major demand growth: Demand is correctly measured in ton-miles, NOT in raw total consumption. While the news-writers of today are discussing OPEC’s impact on crude tankers, the real investors are looking towards the coming replacement from Atlantic basin sources (ie US Gulf and Brazil). The same volume leads to nearly double the transportation need.

6. Bonus: Potential US-China deal: The latest recorded rumour on the US-China deal is for a potential six-year $1trn trade re-balancing. Although this might not be enough as US stakeholders will argue for stronger intellectual property protections, reforms to foreign investment requirements, and a reduction in state subsidies, this marks tremendous progress. We should note that this sort of deal is extremely tentative, but if successful, that level of trade would require an almost unimaginable level of LNG, LPG, crude oil, agricultural, and other raw materials (perhaps even major met coal) purchases from China. Such a deal could lead to the largest boom in crude tanker rates since the previous record set in 2003-2008 and it would be massively bullish for several other sectors including LNG, LPG, and dry bulk.

Despite the progress we’ve seen in the markets, there are lots of misleading narratives ruling the day. The largest one is that OPEC exports will drive future tanker markets and the recent cuts are a bearish signal. This might be true for 2019, but the era of OPEC dominance is gone. Exports from the Atlantic basin, specifically from the US Gulf and Brazil, will be the new kingmakers for tanker rates.

What does this mean for crude tankers? It is the most bullish set-up we’ve seen in nearly two decades and a massive surge of USG-Asia trade could ignite a bull run that would rival the mid-2000s. Why? The route from Atlantic basin producers (Brazil is also growing) to China is double the distance from the Arabian Gulf to China. Distances to India are even larger yet. This means that even with flat consumption, transportation demand growth is set to double. The more OPEC cuts, the more the US and Brazil will have room to expand.

This trend is very bullish for all crude carriers involved, but particularly for the largest VLCC class. DHT Holdings (DHT), Teekay Tankers (INSW), International Seaways (INSW), Frontline (FRO), Navios Maritime Acquisition (NNA), and Tsakos Energy (TNP) are among those most involved.

What are major analysts doing? Some are bullish, but many have gotten cute with short-term timing and have been sending downgrades as they are more lukewarm on mid-19. Not everyone has been missing the forest for the trees, Jefferies is quite positive on the sector and Cleaves Securities analyst Joakim Hannisdahl is certainly not sleeping on the job. He’s printed a 246-page report and points to the oil tankers space as a significant overweight.

Joakim quips that tanker rates have gone “skywards faster than a Saturn V”, which isn’t too far off the track, but where have share prices gone? Nowhere. In fact, many are down. Take our favorite, DHT Holdings. The last time rates were this strong, the share price was $7-$8. The market has completely ignored the strengthening of rates and shift in sector sentiment. Meanwhile, underlying asset valuations have risen more than 10% across the board as all the major industry players are paying attention.

Why is DHT doing so poorly? Part of it is the aforementioned small-cap weakness and trade war concerns, but another major factor is the strengthening correlation between tanker stock prices and the US oil prices. Oil prices have essentially zero predictive power for tanker market rates and in some instances, dropping oil prices can boost contango (ie higher prices in the future) and boost demand for floating storage.

Additionally, volatile prices can lead to additional trades and higher demand for transportation. There’s no predictive correlation to actual performance and if anything, we should see a slight negative correlation, yet here we are. Oil prices have been strongly driving tanker stock prices down (in the short-term). I’m very long tanker stocks and I expect rationality to arrive sooner than later, especially as strong earnings and forward guidance reports are set to roll in.

Major repurchases, superior capital allocation

As we’ve previously covered, shipping stocks are trading at near record lows while prospects are quite strong and current rates have been excellent. Firms have recently stepped up to the plate to repurchase shares. This is an excellent use of capital, but analyst reactions have been mixed.

Deutsche Bank analyst Amit Mehrotra has been the most vocal in his commentary arguing that companies might be better served by keeping cash on their balance sheet. He also cautions against reduced trading liquidity if shares are taken off the market.

In my view, these allocations are clear-cut wins. If a company is trading at a fraction of their net-asset value and has excess liquidity, they should plow whatever they can into buying effective $20-bills for $10. If their liquidity is tight, they should dispose of older assets and use proceeds to buy back shares.

I believe that trading liquidity concerns are a sorry focus point and this tack misses the long-term point entirely. If shipowners want to see their stocks trade at stronger levels, they need to convey trust to their investors that funds will be utilized appropriately. When shares trade at steep discounts, assets should be exchanged for shares, thus optimizing the capital structure. I do however agree with Amit that balance sheet liquidity is important.

At these prices, there is no excuse to sit around at major discounts and twiddle thumbs. Inaction even gets to the point of being abusive with shareholder funds. Thankfully, as we’ve noted, firms have started taking action in droves. I’d previously called out Teekay LNG Partners, DHT Holdings, and Navios Maritime Partners for not repurchasing, but they have stepped up with $100m, $50m, and $50m programs respectively in the past month.

Additional firms that need to get moving? Genco Shipping and Teekay Tankers. Genco trades at nearly a 50% discount to NAV while also boasting a rock-solid balance sheet with around 30% debt-to-assets. Teekay Tankers also trades at a discount of more than 40% and trades at about 3x expected free cash flow.

I believe the best time to buy is when panic is in the air and everyone is cursing the sector. I still believe the risk/reward skew is very strong, and I am very long the sector. Earnings season begins today with Euronav recently reporting. I am looking forward to a string of solid tanker results, hopefully a sign of great things to come.

3 Comments

erik gates

January 26, 2019 at 10:41 am

Mintzmyer…as well as the sell-side analysts…have talked “excitedly” about the supply-demand balance (vessels) ….newbuildings/demolition, etc….for over a year now re dry bulk. Fair enough….but this is a 2-4% swing statistic compared to the implications of a powerful/real China slow-down, an India program/mandate to mine more coal at home, etc. One forgets….SBLK stock is up four-fold from the bottom of a few years ago.
J’s analysis is terrific…and I think he spotted some amazing “trees”….but missed the “forest”: the dimunition of demand in China…has the potential to be scary (coal and iron ore).
I hope he’s more accurate with his tanker enthusiasm.

Erik Gates

January 26, 2019 at 11:31 am

Perhaps…like the stock market, I’m too myopic….but Scorpio Bulkers buying back more than 4 million shares north of $6 per share…..did nothing for shareholders. Soundbites like “vote of confidence by management”…”cushion/support”…well, historically…wrong more than right. In fact, with the stock approaching $5, it shows institutional sellers (or buyers at $5!) might be more attune to market conditions than management. Golden Ocean….almost falling into the same camp. And the brazen/cavalier swashbucklers handling the nickel-and -dime repurchases at Star Bulk…even more pathetic. The minute the stock had another leg down from their initial small purchases…they stopped!

The big picture: Stock repurchases should be used when panic selling ensues….and ONLY then.

Thanks for the good thoughts posted above. The importance of the repurchases in in the underlying value creation of buying $1 worth of vessels (NAV) for say 50-60 cents. It is amazing in terms of the compounding value creation and outside of shipping we can see a similar thing happening with AerCap (AER).

I agree that $SBLK’s execution of their buyback has been very disappointing, but I think that’s more to do with their higher leverage and therefore weaker balance sheet with not a ton of excess liquidity… They did the buyback clearly as more of a signal…

Euronav (EURN), Golden Ocean (GOGL), and Diana Shipping (DSX) earn the highest marks in my book thus far for execution and value creation in their repurchases.